I’ve not had a Cash ISA for years and with good reason. Today I’ll explain why anyone even considering retiring early should steer clear of them.
The true cost of a Cash ISA
Any account that stops you from paying tax sounds great, in theory. In practice, however, the Cash ISA’s the worst destination of them all.
When even the best instant access account pays a measly 0.9%, any money stored here will barely rise in value, particularly when inflation is factored in. No, to have any chance of retiring early, your best bet is the stock market.
Let’s say you have £10,000 and two options. Either you put this money in the Cash ISA, or you put it in a Stocks and Shares ISA. In the latter, let’s assume you invest every penny in a fund holding lots of big, global companies. It returns an average 10% per annum.
After 30 years, the first option will give you a little over £13,000. In the second, you’ll have £174,500! That’s the power of compound interest.
Sure, this example is simplified. Interest rates will vary over a 30-year period (although I can’t see them going up for a while). Average investment returns for the fund could be lower or higher and I’ve not taken into account any fees. You also need to commit to not touching your money for a long time.
Nevertheless, this brief example shows how investing in stocks over a long timeline will give you a far better shot at retiring early than a Cash ISA ever will.
Balancing the risk/reward ratio
Can I speed things up? Potentially, yes. The annual return in the example above is great but not exceptional. You can actually retire earlier (or retire after the same amount of time with a lot more money) if you outperform that hypothetical fund. There’s just one snag. To do this, you’ll probably need to take more risk with your capital.
For me, this means looking lower down the market for smaller stocks that have the potential to be big winners. This requires time, energy, and, yes, a fair dollop of luck. Many minnows go bust, taking investors’ money with them.
That said, the potential returns are massive. Take a look at the share price of drug company Synairgen last week and you get an idea of just how much money can be made over a very short period of time. Now compare this to the Cash ISA interest rate.
A less-risky alternative to picking your own stocks would be to put your faith in a professional investor. To get your money’s worth, be sure to only back small-cap managers who’ve shown they can outperform the market most of the time (it’s very hard to do it every year).
If paying higher fees is something you don’t want to do, however, you could always invest in an exchange-traded fund that tracks small companies around the globe or within a specific country.
Bottom line
Don’t dismiss early retirement as a pipe dream. Take advantage of the best wealth-generating mechanism out there: the stock market. The strategy for getting there may vary depending on how involved you want to be but even a simple approach can yield great results.
Oh, and avoid the Cash ISA.
